Krugman Trashes Geithner's Bank Plan...And Obama

Paul Krugman and other respected observers have come out strongly against Tim Geithner's latest plan to fix the banking system, which is a slightly modified version of Geithner's original plan to fix the banking system.

Krugman also lays the blame at Obama's feet and wonders whether it will destroy his political capital.

[T]the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact. Read all >

As we explained on Saturday, here's what Krugman is so upset about:

Remember the crux of the problem: Banks say their assets are worth 60 cents on the dollar. The market says they are worth 30 cents on the dollar.

Geithner continues to accept the banks' argument that this huge bid/ask spread is just a temporary condition: The market just doesn't understand that the assets are actually worth 60 cents on the dollar. When it realizes this, everything will be fine. The majority of smart economists (at least the ones we read) think this is a crock. The banks are hallucinating (or worse), and most of the assets are worth what the market says they are worth.

In any event, the only way banks can be induced to sell those assets is if someone agrees to pay 60 cents (or more) on the dollar, because otherwise the banks will have to take more writedowns and require more capital. The only way someone will pay 60 cents or more on the dollar is if someone gives them a boatload of free money to be reckless with. That's where Geithner and the taxpayer come in.

In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose.So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem. [The taxpayer's]...

This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work. Read all >